Obama warns of 2nd financial crisis

Bernanke also warns of possible market disruptions

U.S. president Barack Obama, shown speaking at a Miami fundraiser Monday, said Tuesday he expected American lawmakers will reach agreement on how to increase the debt limit "in a sensible way." (J Pat Carter/Associated Press)

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Congress must raise the American national debt ceiling or risk causing another global financial crisis, says U.S. President Barack Obama.

In an interview Tuesday with NBC's Today show, Obama said "the full faith and credit of the United States is the underpinning not only of our way of life, it's also the underpinning of a global financial system. We could actually have a reprise of a financial crisis, if we play this too close to the line. So we're going be working hard over the next month," he said.

But Obama also expressed confidence that Republican leaders want to avoid such a situation and said he expected lawmakers will reach agreement on how to increase the debt limit "in a sensible way."

The government has said it will exceed its $14.3-trillion debt ceiling on Aug. 2.

Later in the day, the chairman of the U.S. Federal Reserve, Ben Bernanke, urged Republicans to support a vote to raise the ceiling. He said threatening to block the increase to gain deeper cuts in federal spending could backfire and worsen the economy.

Bernanke, in a speech in Washington, renewed warnings that even a short delay in making payments on the nation's debt would cause severe disruptions in financial markets, damage the dollar and raise serious doubts about the nation's creditworthiness.

"I fully understand the desire to use the debt limit deadline to force some necessary and difficult fiscal policy adjustments, but the debt limit is the wrong tool for that important job," Bernanke said.

He called on Democrats and Republicans to develop a credible long-range plan to attack the nation's soaring budget deficit. The deficit is on track to top $1 trillion for a third straight year.

Budget negotiators resumed talks Tuesday led by Vice-President Joe Biden. They are trying to reach an agreement that would tie spending cuts with an increase in the debt limit.

An increase of $2.5 trillion in the debt ceiling would allow the government to operate until early 2013, getting policymakers past the November 2012 elections.

Some Republican lawmakers have questioned the Aug. 2 deadline. The government could avoid a default by selectively paying some bills with government tax revenues including making payments on the debt as they come due, they say.

Bernanke challenged that argument. Bernanke said given the size of the debt and the uneven flow of government revenue, such an effort would buy only a short amount of time while raising unnecessary concerns in financial markets.

"While debt-related payments might be met in this scenario, the fact that many other government payments would be delayed could still create serious concerns about the safety of Treasury securities among financial market participants," Bernanke said.

The administration and Congress are now focused on cutting long-term spending, the price for increasing the government's borrowing authority.

Ethanol tax credits targeted

One proposal for achieving that would have the government eliminate ethanol tax credits that pay the oil industry $5 billion a year.

But the Senate sidetracked a move to end the subsidy for ethanol, a corn-based additive blended with gasoline to make alternative fuel.

The vote was 40-59, less than a majority and far fewer than the 60 needed to advance the measure drafted by Oklahoma Republican Sen. Tom Coburn.

Coburn said they are wasteful subsidies for an industry that no longer needs them.

"The days of placing spending programs in the tax code and giving them holy status are over," Coburn said. "Ethanol is bad economic policy, bad energy policy and bad environmental policy."

Coburn's is supported by conservative groups such as the Club for Growth and environmental groups such as the Sierra Club.

The biggest defenders of the subsidies, however, include farm belt conservatives leading the charge for less government.

Ethanol supporters argue that with gasoline prices hovering near $4 US a gallon, it is no time to repeal tax credits that encourage alternative fuels.